This New Target Buyback Should Be Good For 27% Appreciation

Summary

The company recently announced a $5B buyback program with no completion date announced.

Hypothetically, if all the shares were to be purchased right now at the price of $68.11, approximately 73.4 million shares could be bought back.

I believe 27% capital appreciation between now and the end of 2020 is a good return, and I can’t forget to mention that you’ll collect a 3.5% dividend too.

Not all share buybacks are created equal. Some are good and some are bad, I believe it all depends on how they've been funded and the timing of the purchases. Some can be funded via free cash flow, retained earnings, and others can be funded by raising debt. By doing a share buyback, a company can buy shares off the open market whereby reducing the share count and making earnings per share move up and dividend payout ratios move down. When the earnings per share number increases, typically stock prices follow. Usually shares are purchased when a company believes its shares are undervalued or the notion I like to believe is that when they have no better investment than investing in their own shares.

When a company is making money, they can either plowback the money into the company for projects which have the largest return on investments or return money back to the shareholders in the form of dividends. I consider share buybacks as a special type of project which tells me a company has exhausted all options for their already high return on investment projects and now it's time to focus on the "company project". Today, I'd like to evaluate the potential for a share repurchase program which Target (NYSE:TGT) put into place recently.

The company recently announced a $5B buyback program with no completion date announced. Hypothetically, if all the shares were to be purchased right now at the price of $68.11, approximately 73.4 million shares could be bought back, leaving about 508.8 million shares outstanding.

Now, I'm going to take the more difficult approach to determine what can happen with the capital appreciation of the stock by the end of the program if it were to take four years to execute the program. Assuming that the buyback amount is distributed evenly throughout the time frame, we get $1.25B of buybacks per year. If we use the initial estimate of $5.32 for 2017 earnings, we can calculate a net income number of $3.1B which we'll use later on to calculate the EPS at the end of the year if the shares were bought immediately on the first day of the year. Approximately 18.4 million shares could be bought at today's price of $68.11 which would then reduce the total shares to 563.8 million from the current 582.2 million. Using the same net income number we calculated before, we get a 2017 EPS of $5.49. If Target were to operate in a vacuum from the rest of the market, and if we used a P/E of 13.23, we'd get a stock price that's close to $72.65 by the end of 2017.

For 2018, I've assumed an earnings growth rate of 5.9% based on the EPS estimate of $5.49 to give me a 2018 EPS of $5.64. If I were to use the 189.4 billion shares at the end of 2017 and the EPS number I just calculated, then I'd get a net income of $3.2B for the 2018. If in fact Target shares do end at $72.65 at the end 2017 and the buyback was executed throughout the year, then I would anticipate an end of 2018 EPS of $5.82 for an ending stock price of $76.99 when using a P/E value of 13.23 to estimate the price.

If we perform the same rigmarole for 2019 and 2020, I get end of year EPS value of $6.52 in 2020. With this EPS estimate and using the same 13.23x earnings number I've been using, we get an end of year price of $86.21 for the stock which constitutes capital appreciation to the tune of 27%. If we do a little sensitivity analysis, and I lower the P/E multiple to 12.8 to match the current forward looking P/E value, we get an end of buyback period stock price of $83.52 and capital appreciation of 23%.

What Does It All Mean?

I believe 27% or 23% capital appreciation between now and the end of 2020 is a good return, and I can't forget to mention that you'll collect a 3.5% dividend to boot each year. But there are definitely macroeconomic issues taking place right now which can keep the stock down. I'll just be happy enough if the stock gets back up to the $70 level soon. The stock has been like a snowball rolling down a mountain since mid-April, causing the stock to be undervalued severely by my estimates and making this buyback an excellent move on the company's part.

Disclaimer: This article is in no way a recommendation to buy or sell any stock mentioned. This article is meant to serve as a journal for myself as to the rationale of why I bought/sold this stock when I look back on it in the future. These are only my personal opinions and you should do your own homework. Only you are responsible for what you trade and happy investing!

Disclosure:I am/we are long TGT.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it (other than from Seeking Alpha). I have no business relationship with any company whose stock is mentioned in this article.